A Sampling of Advisory Opinion

By

Anita Peltonen

Updated June 27, 2005 12:01 a.m. ET

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Change Is in the AirThe 2005 Mid-Year Outlook by Moneyletter 360 Woodland St., Holliston Mass. 01746 June 24: We have held a moderately optimistic outlook for the U.S. market all during the first half. A phrase we leaned on heavily was "there is overhead room" for the U.S. market to advance. We kept pointing out that, considering the 10-year Treasury interest rate and the outlook for profits, the U.S. market was a "buy." Looking ahead, we still hold to that view, but with lower confidence than before. What has shaken our confidence? The rise in oil prices, for one. It is not the rise in itself that bothers us. Price movements on the commodity markets can have many causes -- most fleeting and set to disappear shortly -- after which prices retreat. But this current rise in oil prices to nearly $60 appears to be based on something more substantial, a combination of steadily rising demand and a shortage of refining capacity. We do not see prices coming down, meaningfully, anytime soon. Aside from oil, the continued weakness in some of the manufacturing numbers has us scratching our heads. In the last two months we have had fairly weak reports from the national ISM manufacturing survey, the New York Fed survey, and the Philadelphia Fed survey. When these surveys started going south in March and April, we chalked up their weakness to an inventory correction and the delayed effect of the end of investment tax breaks in place last year. Here it is June and two of the three surveys are still going down. The New York survey did improve some, but even with that the June report was quite weak compared to those earlier this year.

-- Walter S. Frank

Euro-TrashedBe Careful What You Wish For by MacroMavens 4 Columbus Circle, New York, N.Y. 10019 June 21: Europe's discovering the drawback of a weaker currency. Having long derided Japanese and Chinese currency manipulations for forcing the euro to bear an undue burden of the dollar's weakness, Europeans have recently enjoyed some relief, with the euro notching an 11% decline against the dollar since the start of the year.

Problem is, over the same time, commodity prices (most notably, oil) have been on a tear. As a result, the rise in commodity prices in euro-terms has been much greater than in other major currencies. Essentially, Europe has swapped one problem for another...With oil in euros now flirting with the key psychological level of 50, policymakers are in quite a fix. Even if the European Central Bank embraced the [U.S.] Federal Reserve's view that higher oil prices are a "tax" rather than an inflation shock, if it did cut rates it would only further weaken the currency, thereby exacerbating the rise in commodity prices. [Yet] if it does nothing, the rise in commodity prices could push Europe's enfeebled economy over the brink.

While these weighty issues will be thrust onto the back burner when oil prices inevitably correct, with the long-term secular commodity bull in place, they will are sure to resurface in short order. (Too bad Europe blew its chance of having oil priced in euros, with its fraying political union). Will the hoped-for panacea of euro weakness be the thing that destroys the EU economy in the end?

-- Stephanie Pomboy

High Energy a DragEconomics Today by Reliance Economics 3384 Peachtree Rd., Atlanta, Ga. 30326 June 20: Inflation news [has been] mixed. Both the consumer- and producer-price indexes for May showed little inflation, due in part to a drop in energy prices, which have since rebounded strongly. The...consumer-price index declined 0.1% last month, but was still 2.8% above a year ago. The core CPI, which excludes volatile food and energy prices, rose 0.1% but was 2.2% above a year ago, about the same as in recent months. The combination of moderate economic growth and 2+% core CPI inflation make it very likely the Fed will raise the fed-funds rate to 3.25% on June 30 and probably to 3.5% on August 9. During the second half of the year, there is likely to be a pause at some point in the Fed's raising of the fed-funds rate. Other inflation news was worrisome -- crude oil's high and commodity price indexes sharp rise...Despite steep price increases, U.S. oil use is running 2% and gasoline use is running 3% above a year ago. The housing boom is one factor behind strong demand for energy. High energy prices are a negative for the economy, depressing real incomes and aggregate corporate profits.

Moderate growth and stable inflation have been favorable for stocks, but not bonds. The Standard & Poor's 500 stock index jumped 1.6% [the week before] last. The 6.4% rally in the S&P 500 over the last nine weeks has erased all the losses earlier this year, leaving the index up 0.4% from year-end and 7.2% from a year ago. Bonds, on the other hand, have been falling in price recently. The yield on the 10-year Treasury has jumped from a low of 3.89% on June 2 to 4.08% on Friday. In recent weeks, stocks have been getting more expensive versus bonds, and $60 oil and rising short rates are negatives for stocks. Nevertheless, earnings are likely to be strong enough to support stock prices.

-- Annie Dill

Pensions Math and BeyondStrategy and Economics by Morgan Stanley 1585 Broadway, New York, N.Y. 10036 June 13: Unless equity markets and bond yields rise significantly over the next several months, increased contributions to defined-benefit (DB) pension plans will likely drain aggregate corporate resources, and thus, potentially, taxable corporate income. Budgeteers worry about the fiscal impact of DB contributions. To the extent that contributions substitute for taxable compensation, they could reduce individual income-tax receipts, and the effect on corporate tax receipts could be significant. And because corporate cash flow is one driver of capital spending, there are concerns that such contributions will also divert resources from investment outlays....

The risks? As I see it, the effect on aggregate profits and thus on government budgets from increased defined-benefit pension contributions is highly uncertain. Simple estimating rules-of-thumb may overstate or understate required contributions as well as their effect on income and receipts because funding rules are complex and requirements for so-called catch-up contributions likely are heaviest at companies with little or no taxable income. In any case, in my view the impact on capital spending likely will be small even if aggregate contributions are substantial. That's because healthy companies with access to capital markets likely will have no problems executing capex [capital expenditure] plans, even if they must increase pension contributions.

-- Richard Berner

Pondering AlternativesDeVoe Report by Jesup & Lamont Securities 650 Fifth Ave. New York, N.Y. 10019 June 9: Before [making her name] in movies, Demi Moore also worked as a model. For one shoot she, a man and another couple posed apparently naked sitting in a hot tub for a brochure promoting that product. After becoming [one of] Hollywood's highest-paid female actresses, she was asked on a late-night talk show about this modeling job. She answered icily, "There were absolutely no other jobs, I was broke and I had two alternatives, starvation and you know what. No way! What would you have done?"....

Like Ms. Moore, some Fed officials have also bristled when asked about their policy decisions (since March 2000)...Undoubtedly, without any Fed intervention, the recession would have been somewhat deeper...The Fed's 13 interest-rate cuts, bringing interest rates to 46-year lows combined with two tax cuts and the added stimulation from near $400 billion budget deficits helped bring about those "imbalances," as Fed Chairman Greenspan calls them. That those "alternatives" cited by Fed spokespeople...would have been worse without their massive stimulation (a deeper recession and the risk of deflation) is debatable. Since the recession was extremely mild...doing absolutely nothing probably would have made the recession deeper; how much deeper and longer is impossible to determine with any degree of accuracy.

I stand by my conviction that the first interest-rate cut in Jan. 2001 accomplished its mission -- boosting the stock market and reviving consumer confidence [and] stimulat[ing] consumer spending, mission accomplished. The next dozen interest-rate cuts were questionable.

-- Raymond DeVoe Jr.

Entrepreneurial Droop?vFinance Entrepreneurial Confidence Index by Center for Innovative Entrepreneurship 3010 N. Military Trail, Boca Raton, Fla. 33431 Late Spring: The vFinance Entrepreneurial Confidence Index (VECI) plunged 29.7% in May from the previous month, as sharp declines in interest in health products and services and specialty retail offset a modest increase in computer software and media. The steep drop brought the Index 16.7% below the level of a year ago.

The May reading of 146.2 (2002=100) puts the VECI at its lowest level since October 2003, and the 29.7% decline represents the largest decline since we began compiling the index in September 2001...Highest level of interest (share of total responses): computer software and services (11.7%); real estate (11.4%); leisure (9.6%). Lowest level of interest (share of total responses): conglomerates (0%); chemicals (0.3%); aerospace and defense (0.5%).

-- Kenneth McCarthy

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